A collection of observations, news and resources on the changing nature of innovation, technology, leadership, and other subjects.

December 14, 2009

Cloud Computing and the Evolution Toward the "Outside-In," Virtual Enterprise

A couple of weeks ago, I attended a very stimulating meeting in Madrid sponsored by the Bankinter Innovation Foundation. The Foundation was started in 2003 by Bankinter, - one of the largest commercial banks in Spain, - in order to foster entrepreneurial innovation in the country.

One of the the Bankinter Foundation’s main initiatives is its Future Trends Forum (FTF), a multi-disciplinary international think tank of over 300 experts that together aim to anticipate the major social, economic, scientific and technological trends driving innovation around the world. The Foundation holds two meetings a year in Madrid, each focused on a major trend previously chosen by the FTF members. In addition to a subset of the members, subject matter experts are invited to attend and speak at the meetings.

The 13th FTF meeting took place the first week of December. The topic was “The Crowd in the Cloud.” Given my interests in cloud computing, I was invited to participate.

Cloud computing has mostly been associated with computing utilities, where companies can get access to computing resources, storage, software platforms or applications as-a-service over the Internet from a variety of third party providers. As I will discuss below, the cloud concepts are being extended beyond infrastructure to Internet-based business and consumer services as well.

But an even more intriguing cloud trend is emerging, that of crowdsourcing, where advances in Internet-based social networks, are enabling companies to increasingly rely on people and firms outside their boundaries for a lot of the work previously performed only in-house. In this posting, I would like to write about the context underlying these cloud trends. I will return to write about the FTF Crowd in the Cloud discussions once the document on the meeting is publicly available.

While the notion of companies outsourcing work to individuals, partners and supply chains is nothing new, the degree to which it is now possible to do so is truly transforming the very nature of the enterprise, as well as the nature of work in the 21st century.

For most of the last century, the vertically integrated firm has been the dominant model for organizing work, especially complex work, as opposed to getting such work done through many independent small companies or self-employed people. According to classical economic theory, a firm should be able to find the cheapest, most productive goods and services by contracting them out in an efficient, open marketplace, rather than by developing them internally within the company. Why then, did the vertically integrated firm arise?

The reason was first explained by British economist Ronald Coase in a famous 1937 paper on “The Nature of the Firm.” Professor Coase explained that additional transaction costs are incurred, - what economists call externalities, - in obtaining goods and services outside the firm, tasks such as searching for the right people, negotiating a contract, coordinating the work, managing intellectual property and so on.

A firm will keep expanding and adding people as long as doing so is less expensive than securing the additional services in the marketplace. This simple, elegant explanation has become known as Coase’s Law, and earned Professor Coase the 1991 Nobel Prize in economics.

But, for a variety of reasons, there are limits to what can be produced efficiently within the firm, as well as to how big a firm can get and still remain competitive against faster moving companies. All that growth generally leads to ever larger, multi-layered hierarchical organizations. The additional layers of management and staff functions can cause the firm to become bureaucratic, significantly impacting its ability to quickly embrace new ideas and technologies when market conditions change. A well managed company strives to achieve an optimal balance between what work gets done within and outside its boundaries.

Advances in communications technologies, industry standards, and competitive pressures have been changing this inside-outside balance for decades. The easier and faster it is to interact with partners outside the company, the more modular and standardized the components of a product, and the stronger the competitive pressures to lower prices, the more companies have embraced outside partners and supply chains.

This trend has significantly accelerated ever since the explosive growth of the Internet in the mid 1990s. Ever since, communications and transaction costs have been dropping precipitously. We have seen the emergence of what I think of as the outside-in enterprise.

Before the advent of the Internet, larger firms used different, more efficient, and often proprietary communications and information sharing mechanisms within their own company from those used externally. This disparity tended to make such firms rather inward looking, as it was so much easier to interact with people inside the company that with those outside.

After the advent of the Internet, companies started to embrace the technologies, standards and capabilities of the public Internet inside their own organizations, building what we called intranets. They developed similar Internet-based capabilities to connect to their outside partners - extranets. The once rigid definitions of inside and outside began to blur, and we saw the emergence of the virtual enterprise.

This blurring of boundaries started a kind of inversion of Coase’s Law. Improvements in Internet-based capabilities have continued to lower the costs of getting services done in an efficient, open marketplace. In the last decade, we have seen a growing trend toward virtual enterprises, as more and more tasks can now be more efficiently carried out by working with outside partners. Moreover, the rise of globalization has significantly increased the competitive pressure on companies to rethink their inside-outside balance. The vertically integrated enterprise of the industrial age is giving way to a more distributed, open, collaborative virtual enterprise.

Cloud computing, I believe, represents the evolution of IT towards an Internet-based computing model explicitly designed to enable this transition from inside-out to outside-in organizations. More and more, a company needs to be focused on the world outside its boundaries, not only because much of its work is now being done with outside partners, but in order to better understand our fast changing market environment so it can make better business decisions, as well as to better respond to the varying requirements of its clients, so it can provide, each of them, the best possible products and services.

Cloud computing represents the rise of the Internet of services, enabling computing power and applications to be consumed where and when it is needed as-a-service. As digital technologies are increasingly penetrating every nook and cranny of the economy and society in general, we are seeing an explosion in the the volume and variety of cloud-based services flowing through the Internet. Consequently, the cloud computing model requires a highly disciplined, industrialized approach to the management, delivery and consumption of services.

Infrastructure services - computing, storage and various kinds of software platforms and applications, - have been the easiest to standardize and offer as-a-service over clouds. But increasingly, this same outside-in, cloud model will be applied beyond infrastructure services to encompass a wide variety of standardized, mass customized services for individuals and companies.

Enterprises spend a lot of time, expense and energy doing similar tasks in different ways for no good business reason. For example, it is not unusual for different divisions of the same company to use different HR, finance and accounting processes, just because that is the way they evolved over time. Standardizing and consolidating many of these business services within the company can result in significant savings, than can then be applied to areas that offer true competitive advantage which the company may not presently be able to invest in, such as improved customer service or increased R&D and marketing.

Moreover, many of the differences in business services among companies within the same industry are unwarranted and wasteful as well. Just like companies have become more efficient and adaptable by embracing public Internet standards for their own IT infrastructures, they should be embracing standard business services and industry best practices whenever possible. The use of such standard services and best practices have brought major improvements in productivity and quality in manufacturing industries over the past three decades. Cloud-based business services should make it possible to bring similar productivity and quality improvements to many customer oriented and front-office services.

Crowdsourcing takes the discussion to the next level by exploring the degree to which a company can extend its outside-in model beyond IT and business services. Can a company rely on people outside its boundaries to help it find innovative solutions to some of its most complex problems by leveraging the mass collaboration made possible by social networking capabilities?

This was the topic we discussed over two days at the Madrid Future Trend Forum, where we heard a wide variety of opinions and points of views. As with previous Forums, the information is currently being analyzed and the findings and recommendations will be subsequently published in the Crowd in the Cloud document. I will return to the subject once the document is published and publicly available.

Comments

Irving,

You're in a fairly privileged position in that you can 'test-drive' a number of brands of IBM 'Cloud Computer'. There's the recently-announced 'Solution Z' built out of System/Z with SLES/RHEL Linux; a number of Power6/Power7 servers which are quite capable; hardware built out of Blade Servers with Intel processors; and the one I develop, http://www.kaust.edu.sa/research/labs/supercomputing.html and successors. And there might be some more.

It feels as if 'cloud computing' at the moment is mostly the business of running seminars, selling hotel rooms, and so on; not really the business of developing, qualifying, manufacturing, selling-and-servicing the hardware; and coming up with the valuable software that turns 'hardware' into 'solution'

Would you consider taking a tour around the world that exists 'behind the IBM badgelock', and reporting on what's for sale ?

Customers can start doing all this today. I'm not sure that they all realise it.